The Fast No Paradox

Even experienced startup CEOs will tell you that raising funds is an important and challenging part of building a company, yet often their least favorite. No surprise. The dog and pony show gets old quickly. You can’t tell who is really interested and who is just wasting your time. And you’ve got better things to do, like getting back to building your business. So how do you manage an efficient process?

The other day, a startup CEO came in to pitch our firm, Sapphire Ventures, during his tour de force of Silicon Valley VCs. We had barely gotten through intros plus a quick discussion about our growth investing expertise when he brought it right down to brass tacks — the fundraising process itself and his expectations of it.

“I love fast no’s,” he said.

He hit the nail on the head. Turns out managing the process for fast no’s is more efficient than fast yes’s.

Beware the fast yes

The slow no will kill you, but its contrapositive is definitely not true. Beware the fast yes. Any investor worth his or her salt should do proper diligence and spend time socializing the investment with the full partnership. After all, a VC firm is supposed to be a committed partner on your multiyear journey together. So expect (good) investors to dig into your business, strategy and numbers; call your customer references; and spend some real time getting to know you.

This is in your interest as well. A VC who gives you a fast yes may be more likely to re-trade the deal during the closing process, especially if her other partners have unanswered questions. Worse yet, that VC is more likely to walk away at the last minute, wreaking havoc on your process. And still worse, you don’t want to be stuck with someone you barely know, who doesn’t understand your business or market, owning a large piece of your company and having a big say in decision-making. Think of choosing an investor the same way you choose your management team, with one key difference: you can’t fire your VC if you choose the wrong one.

On the flip side, you also don’t want to waste your time with all the folks who are unlikely to get to a yes, doing all that work, and “hanging around the hoop.” So how do you strike a balance between the two?

In short, manage your process and your prospective VC investors to (1) eliminate false positives, (2) demand transparency and (3) avoid obsessing over valuation.

Eliminate false positives

Any VC with whom you’d want to be in business will eventually uncover major business risks during the diligence process; so spare everyone’s time and discuss them upfront. Most risks can usually be managed at the front end of a process through discussion and diligence, but an undisclosed risk that comes up late in a process can be a showstopper. If you put all of your cards on the table upfront, the bulk of the process becomes confirmatory in nature, and you have a much higher likelihood of closing once someone digs in.

At Sapphire, our approach is for the lead partner on any prospective investment to quickly bring one or more additional partners into the mix, with each of them asking questions to address key concerns early in a process. We’ve found that this helps minimizes the chance that a deal will end up in the false positive bucket or that a new risk will be surfaced during the confirmatory diligence phase.

Demand transparency

Demand transparency into the steps of the firm’s decision-making process. This will help you know where the VC firm stands and the timeframe for each step. You’ll know when VCs aren’t following their own articulated process — a red flag that they’re just on a fishing expedition or too busy to dig in.

Moreover, push VCs on what their term sheet really means. Is it meant to represent a final deal they would be willing to close on or just a step in the negotiations? Ask around about the VC’s reputation on re-trading term sheets. For instance, when we issue a term sheet, it means that our partners have voted and the deal is, as Chick Hearn would say, “in the refrigerator” — the door is closed, the lights are out, the eggs are cooling, the Jello is jiggling and the butter is getting hard. You get the point. For other VCs, a term sheet may signal something very different.

Don’t sweat the price

Lastly, don’t obsess over valuation. I know every dollar feels super important at the time, but it really isn’t in the long game. You can do the math, adding in dilution from a subsequent round and an assumed exit, to prove it to yourself. The market will set valuation anyway. If anything, my advice would be to manage to a fair price — one that gives you credit for the growth and value you have created in the business but that also gives your company runway to exit or raise a subsequent round at an attractive step-up to the prior round.

These days we too often see headlines about the fallout from companies that grew irresponsibly (based on uneconomic customer acquisition costs), spent unsustainably, or compromised on integrity — often due to the pressure of justifying the valuation at which they last raised money. In our view, raising money at a fair price not only facilitates a sustainable path to raising your next round but also is the best way to position you, the entrepreneur, to maximize your success.

Get the porridge just right

So in conclusion, beware the gunslingers and cut loose the hoop-hangers. Insist on transparency. Relish the fast no. When you do engage deeply, treat diligence as a two-way street. And when it comes to valuation, be long term greedy, not short term greedy. It may feel like you’re leaving money on the table, but future you will thank you for setting yourself up well for the path ahead.